Defaults?

The new boss at Scotiabank raised a few eyebrows (and hackles) when he said 20,000 people with bank mortgages – or 2.5% of the Scotia portfolio – could be “vulnerable” to defaulting on their loans.

If that’s any indication for all the Big Guys (and likely is), a mess more people are going underwater and may never come up again. You know why. Folks borrowed money at 1.5% or so with variable rates that are now cruising towards 6%. Households have hit trigger rates, seen monthly payments swell bigly or had their amortizations pushed out thirty years and more. Many people have had 100% of their monthlies going to pay interest on giant borrowings. So much for building equity. And meanwhile house prices have come under pressure, exacerbating the squeeze. If you ever put on your kid brother’s undies by mistake, you know the feeling.

So what happens in the instance of a default?

Depends where you live. Provinces have different rules, from a power of sale proceeding to a foreclosure or negotiated buy-out. The main thing to remember is that banks don’t want to own houses. So ‘distressed’ properties will eventually always come to market.

That doesn’t mean a $1.3 million home (2021) could be yours for $650,000 in 2023. Properties that owners have given up on almost always trade hands at market price, or a little less. But any surge in listings will ensure valuations keep falling. Meanwhile just surrendering on your mortgage payments and signing over the real estate does not get a borrower off the hook. The lender must be made whole, which includes the full principal amount repaid plus early-payout penalties, interest and legal costs. It’s a nightmare.

But wait. Aren’t the banks protected from losses by the taxpayers?

Yup. That’s what CMHC insurance is all about. And the vast majority of people getting into trouble would be insured borrowers. But there’s a process to go through before the agency compensates a lender. And that’s partly why a bank will do everything it can to prevent default. Some payments can be deferred and added to the principal, for example. The amortization period can be extended. Or they can merely take your children.

Now here’s the news.

Our banks are regulated by the dudes at OFSI – Office of the Superintendent of Financial Institutions. They’re seized these days with declining real estate, historic levels of household debt and massive bank mortgage portfolios. Capital requirements for the Bay Street giants were recently increased. A month ago we heard the stress test (now in the 7% range) would not be modified or punted. Now it seems we’re on the cusp of new mortgage restrictions which will not be good news for the Spring rutting season.

We’re told OSFI will announce “new constraints on mortgage lending” in its ongoing efforts to protect the financial system. (The regulator doesn’t care about your mortgage, only your mortgage lender. Mom lied. You are not special.) It says: “We will look at a broader range of debt-serviceability tools, incl. debt-to-income constraints, debt-service constraints, as well as the stress test tool.”

You can be 100% certain new rules will not make borrowing easier or cheaper. In reality, getting a mortgage is about to become more onerous and credit likely to be restricted as a result. So add this to the list of things nobody expected a year ago: an historic increase in the Bank of Canada rate, mortgage costs tripling, a 7% stress test, a 50% collapse in urban house sales, maybe a recession, vacant house taxes imposed or increased, a foreign buyer ban, a national flip tax, crumbling valuations and more to come – another round of rate hikes this month.

Back to the banks.

Scotia’s share price has fallen 26% in the past year. All of the Big Five have lost ground as central bank tightening did a number on stocks, growth and (yes) real estate. Could be more to come, if the CB hikes again (it will), OSFI makes it harder to people to get mortgages (likely) and we see a recession in 2023 (50% probability). Of course, the bank stock plops will be temporary. None of them are worried. If you own an ETF based on the TSX, you have good bank exposure. This year Bay Street could once again outperform Wall Street, so do it.

Meanwhile, this is no time to buy a house, unless you face spousal garroting. The bottom is nowhere in sight.

About the picture: “Greetings from Manitoba Whale,” writes Bruce in (of course) Manitoba. “Great respect for your time and effort keeping us all informed. The information we have gleaned from you and your blog will positively affect our family for generations. One of our kids began working full time in the USA, and likely will remain there for a decade or two.  We were wondering if you could spend some time suggesting what do do with financial tools like the TFSA and non registered accounts, etc . Should we as parents still max out the TFSA out? Thanks again, and I hope the dog picture will make it to the blog.”